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Homework answers / question archive / Aston University - BF 3314 Which of the following increases basis risk? A large difference between the futures prices when the hedge is put in place and when it is closed out

Aston University - BF 3314 Which of the following increases basis risk? A large difference between the futures prices when the hedge is put in place and when it is closed out

Finance

Aston University - BF 3314

Which of the following increases basis risk?

    1. A large difference between the futures prices when the hedge is put in place and when it is closed out.
    2. Dissimilarity between the underlying asset of the futures contract and the hedger’s exposure.
    3. A reduction in the time between the date when the futures contract is closed and its delivery month.
    4. None of the above.

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Answer:

b )

Step-by-Step explanation

Basis risk is an inherent trait of a trader to hedge the risk associated with the stock prices. The risk increases if the future contracts prices and the hedger's exposure is not similar. This means that the trader did not expect the price of the future contract to vary and therefore, increases the risk. Hence, the correct option is B.

 

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